Arlington Econometrics First Quarter Commentary January 1, 2010

The Last Apocalypse?


My work has always been predicated upon using quantitative modifiers to enhance portfolio value through greater efficiency of information processing and the creation of momentum-driven asset allocation models. As a result client accounts didn’t suffer to the extremes of others during the past 2 years, and rebounded with greater aplomb as the markets gained their footing once again. Our methodology and its consistent point of view has enabled clients to benefit without compromising investment expectations. The underpinnings of Arlington Econometrics’ objective data analysis is to sift through exogenous noise, and unnecessary emotion, to provide modest, if not superior, enhancements to net performance over time.

Markets.
Market crashes are inevitable. Last year was not the first such crisis I have seen. While most indices collapsed mightily in the past 18 months, history has shown that, after the dust settles, those same indices go on to make new highs. Thus, any rational methodology should be designed to mitigate the severity of downside risk when crisis occurs, and to maximize upside leverage during a period of rebound. Unfortunately, most don’t and investors pay an ultimate emotional and fiscal price.

We continue to have a stagnant global economy. There are, to be sure, pockets of strength geographically. Where imbalances occur, markets seek equilibrium. Any problems that persist are embedded in the infrastructure of government, finance, and markets. To wit: Deficits create a weight around our financial systems; currencies are “uneven” and vex global trading patterns; historical demographics are changing, necessitating a new orientation towards healthcare, agriculture, natural resources, energy, and national defense. We cannot ignore these problems, but we might also be able to capitalize from them as nations and as investors. In spite of those data, macroeconomic forecasts are noticeably stronger today than one year ago.

In short, we don’t have to have all the answers today. We might not even know the names of companies that could become market titans in the future. We need only to apply our metrics of evaluation and consistency to come up with the right decisions for a longer view to become successful.

For example, I believe, that successful investments take time to gain traction. Unfortunately, I am usually not “first on the scene.” A more plausible scenario for me would be to identify the macro-opportunity, and to let a company fill the void over time with repetitive earnings. That provides me an outcome that is rational, time-tested, and less panic-driven. It also removes the pain and anxiety of being wrong, like the dot.com enthusiasts who followed the crowd a little early.

The most important questions for investors in the period ahead revolve around how the current climate of fundamentals meld with the psychological climate of mistrust which, I believe, is stronger globally than any set of representative data we have analyzed so far. Although markets have shown a moderate rate of acceleration from their lows, nothing has yet moved the meter in changing the appetite for risk or the divide that exists between sophisticated investors and the average citizen. That worries me enormously.

The long view of investing, as I previously alluded, is cyclically positive. The effectiveness of that data, however, is rooted in the stability of the financial system. We not only have to battle shifts in traditional demographic themes, historical metrics, and market fundamentals, but we need to assuage a global populace that is disinterested in our rhetoric, and still suffering from the effects of the apocalypse they endured during the last year. The public’s rage directed at global financial institutions has reached disproportional levels. Until we in the industry address that disapproval no fancy television commercials or hyped-up advertising will be sufficient to coerce their dollars, or their trust, back.

Strategy.
As the global credit crisis slowly recedes, our focus shifts from brinksmanship to profit-making. We are impeded somewhat by lower flows of investment capital at the Federal, corporate, and personal level. To be sure, we are “awash” in stimulus packages targeted at one sector or another. But the cascade of stimulus money is no replacement for moral leadership in areas such as public health, renewable energy, infrastructure, bio-sciences, technology and national defense, nor for a renaissance in consumer confidence which, up until now, has been sorely lacking.

Globally, it is inconceivable that nations “can go it alone” in this internet society. Remediation is borderless. Going to bed hungry and impoverished are not viable options for citizens of this planet. If mere survival is the highest aspiration of a nation, their sights are set too low, or we have failed to provide the resources for them to dream bigger. The gap between rich and poor is widening. Some countries do not experience these disparities, others do to the extreme.

Solutions are not quarterly by nature, nor do they respond to anniversary dates on the calendar. Instead, they are cyclical, generational, and need a generational mindset to transact.

It is true that norms are changing. Our rational approach to yesterday’s problems might not work today or tomorrow. But logic and common sense never become antiquated. That is why everyone intuitively acknowledges the problems, but becomes immobilized by the Herculean effort required to address them. The last market catastrophe was exacerbated by a failure to address these breakdowns, while remaining dispassionate and inert as long as things kept going our way in the short term. Burying our heads this time around is not an option.

The creation of moral imperatives is not the “other guy’s” responsibility. Each member of society is part of the fabric of his culture. Whatever fears might hold you back also hold back progress in addressing cultural dynamism. While we expect bankers and monetarists to exert wholesale influence over financial matters, core moral values reach us in many other ways, and ultimately resonate more deeply than government dogma.

As investors, we need to be cautious about overweighting the rumors, to the exclusion of solid fundamental analysis and prudent methodology. This coming year we just might see a diminution in returns, an increase in hysteria/disbelief, and greater volatility in trading of financial instruments before patterns return to more nominal levels. Finding the right equilibrium from amongst the chaos will be the investment goal for 2010.

The trading markets and the economy are not necessarily functioning in lock-step synchronicity while we attempt to reverse course from the global recession. In the past I have referred to this decoupling as a “parallel disconnect,” a period during which the economy and the markets only appear to be moving congruently, but in fact are accelerating at different rates of speed, altogether. Right now, the financial market’s recovery is obviously happening at greater pace than the rest of the economy.

Conclusions.
My raw data is not altogether positive in the short term. Already we have rebounded from valuation lows in a near-linear fashion, making any additional upleg extensions hazardous for late-entry. As the national debt expands it raises the spectre of higher interest rates to finance our obligations from within and abroad. The alternative, allowing the economy to flatline, would be calamitous. The question is “How long can the market sustain an intermediate, unabated advance in the face of imposing economic circumstances?”

My vision (and my numbers bear this out) is for the market (and the economy) to focus upon secular themes that offer the highest probability of earnings growth and sustained capital gains. We have seen an acceleration in the price of health sciences equities, but not yet matched by a consistency in earnings acceleration patterns across the board.

As money seeks new breadth of opportunity, those sectors which offer the next generational upleg are: Alternative Energy; Agriculture; Water Filtration; Biotech; Brick and Mortar Infrastructure; Technology; Aerospace; and Pharmaceutical Research. The bond market has temporarily lost relevance to long-term portfolio allocation strategies, as interest rates transition from lower to higher.

History tells us that there is always an upwards bias in the stock market. It is the nature of man to be “greedy.” As the fictional character Gordon Gekko once said “Greed is good,” I agree. But I would add that capitalism has an inherent “morality clause” which can drive greed to be the engine of constructive profit-making, and not the apocalyptic mess we just fashioned.






Asset Allocation:
Equity 50%/Fixed Income 30%/Cash 20%

Market Commentary for the week of December 21, 2009

Don’t be foolish.
Who do you trust more?
(1) Gene Hackman
(2) Sam Waterston
(3) Willem Dafoe

Ah yes, a cop, a district attorney, or the son of God.

You may not know it, but these three actors, and others, are the “voices” of today’s financial institutions on television and radio. Which begs the question: “Does the subliminal intonation of financial-speak really influence where you’ll go with your money or who you trust more?” Can the media actually influence the purchase/sale decision-making of the public?

Hey, they can if it’s automobiles, whiskey, vacation spots, clothing, and toothpaste. Why not investing?

Throughout the fiscal crisis of 2008-2009 all the networks seemed consumed by the gravity of the subject matter, not the least of them being business networks like CNBC, Fox, MSNBC, CNN and others. (Under full disclosure, let it be noted that I am a contributor to some of those outlets listed above.) Seemingly, minute by minute, coverage of the financial crisis pelted you with fact, opinion, and rhetoric. In days gone by, we used to wait until the next day’s newspaper to know what happened yesterday. Today, the proliferation of instant access, instant opinion, provides the means for hasty decision-making and incomplete vetting of the subject matter.

“What?” you say. “Incomplete analysis?” “Yes” I respond.

Motivation.
The media, indeed, adds a sense of immediacy to our news, but it can also turn a cyclical situation into a frenzy, resulting in more hysteria and unnecessary volatility. Adding fear to an already frightful situation exacerbates the cauldron of doubt, skepticism and mania.

Consider that more people are now “plugged in” to news through internet and instant media access, adding to the ingredients for mass hysteria. When conditions are good, the media can fuel an upswing; when things go badly, the networks are jumping over each for “ratings first,” telling us how much worse it’s going to get, and stoking the fire of negativity.

It is probably naïve for me to hope that financial media might actually serve the public’s needs by answering basic questions, and making the hard look easy. But consider there’s danger in serving its own needs first, playing on the vulnerability of listeners and giving them advice which might not be appropriate to their unique situation.

Value.
While it is also presumptuous of me to assume that all media are bad, or that all viewers are gullible, it is safer to harken back to an era when investing was a noble undertaking, a means between you and your ultimate goals, rather than a pitch-box through which all kinds of junk is thrown at you without empathy or consideration.

Commercials and opinion will always be with us. Not long ago we heard how “When one company speaks, people listen,” or that they “Earned it” (who better than John Houseman?).

My contention, though, is that the sheer enormity of financial coverage and commercials can also lead to a sense of helplessness and a feeling of being overwhelmed. Losing control of information is as bad as too much information.

(There will be no commentary published next week. Our next contribution will be the Quarterly Market Outlook, January 1, 2010. Happy Holidays!!)

Market Commentary for the week of December 14, 2009

Crossroads.
Ultimately, we’re going to have to come to grips with whether or not we are in a bull leg within a secular bear or a renaissance cycle signifying the first upleg in a new bull. All semantics aside, it does matter how we define these trends because asset allocation, sector allocation, and investor expectations depend upon a “correct” assessment.

Fortunately, we can sit and allow today’s remarkable upside capitulation to continue, and count the benefits that accrue to our retirement accounts. But, at some point, if we don’t get the definition, the moment, correct we might be destined to repeat an ugly lesson of jumping into the pool too soon, with disastrous results as a consequence. (As a matter of comparison, for example, Japan has been digging out from an abysmal bear market since 1988).

This year’s capital gains have come quickly and without interruption. Under typical metrics that type of cycle is impossible to sustain. For that reason, some are looking for an identical down-leg to follow. Additionally, the magnitude of this upswing has been so significant that we have eradicated the losses of the previous bear leg. Some might conclude from that data that we need only to “breakout” to new highs to confirm a new bull market.

So which way to go?

Just the facts.
I believe portfolio allocation decisions must be made upon the existing trend data not the expected, or anticipated, direction of the trend. Therefore, I consider us to be in a secular bear market, and the beneficiaries of a remarkable upleg within that trend. Additionally, the current relative strength quotients of today’s bull cycle are unsustainable in the near term and potentially high risk entry opportunities. These data are true for the majority of global baskets that have experienced a bull cycle since March, 2009.

Further corroborating my conclusion is the secular bull cycle in defensive sectors such as Utilities, Basic Materials, and Fixed Income.

In the short-term, these defensive secular trends offer significant counter-cyclical balance to the secular downtrend in earnings growth and traditional “front-end of the market” sectors. In sum, global synchronicity has the financial markets on the cusp of something positive, but not quite there, yet.

Up or down?
One might conclude, then, that I am bearish about investing. Quite the contrary. Rather than parking money in a tin can in the backyard, I see a tapestry of fundamental and quantitative needs that are ripe for harvesting. This is where the market has become more subjective and more individualized in its opportunity. We are past the point of preserving net worth against decline. Our mission is to find strategic ways to make money grow.

As with most things, it is smart to look at the alternative case scenario. With money trading at cheap levels (low interest rates), the best game in town is growth stocks. In spite of the perceived risk in owning equities, the best way to obtain anticipated nominal rates of return is to balance sector and equity selection so as to overweight upside probabilities of performance, and to underweight downside probabilities of performance, based upon continued decline in earnings.

In a few weeks, I will publish the 2010 first-quarter commentary in which those opportunities will be discussed. Hang in there.

Market Commentary for the week of December 7, 2009

What we see.
While the stock market continues to surge, economic news has concurrently been surprisingly good. An increase of corporate expenditures in recent months has been a hopeful sign that investor psychology might have changed and that employment might reverse its current downtrend. Few think we have definitively turned a corner, but many are curious about what positives might lie ahead.

One potential source of good news is a series of reports that currencies are stabilizing and that interest rates are finally catching up to economic assessments. In other words, the age of expansive borrowing and speculation is being replaced by fundamental valuations and a “cash is king” mindset.

Of course, subtle changes become amplified over time by momentum shifts, and the hope here is that secular growth patterns emerge that might lead the way to better portfolio balance. For a time, stock-picking was a better tool than market analysis, but that time might be coming to an end.

What we think.
The bears need not be humbled, however. With the near-linear explosion in equities since last March, the market could be subject to a correction, one for which many have been already waiting months.

The good news is that there is enough money on the sidelines that any meltdown might only be temporary, and certainly a new buying opportunity.

There is also a growing appetite for non-U.S. equities. Emerging markets, commodities-driven regions, and fresh intellectual capital are all hot spots for money seeking new opportunity. As well, returns are likely to be compound-multiples of those obtained in traditional Western markets.

Obviously the only factors that could change the global appetite are war, and political instability. Although those are unlikely, investor skittishness is not something we can predict at this time.

Nevertheless, the coming year holds more promise than last year when the general consensus was quite poor. Despite that, the year turned out quite nicely.

What we hope.
Another factor influencing my attitude about stocks is the dearth of quality bond purchases available. Last year at this time the credit crisis pulled the rug out from under any credit certificates and caused prices to drop precipitously. Despite, or perhaps because of, the recovery in price and credit this year, there just aren’t enough good issuers at sufficient yield to make the trade worthwhile.

Therefore the equity markets become, de-facto, the only game in town.

This double-edged sword takes the alternative investment scenario out of play and limits the flexibility of portfolio managers to diversify adequately in the event of a turnaround in sentiment. While I am loathe to be a one-trick-pony, the market is shaping up as my only source of asset balance. I will carefully monitor our equity sector allocation as well as our cash reserves so as not to be too overexposed to risk next year.

The last time money was this cheap a speculative crisis emerged. We can only wait to see whether responsible fundamentalists or trader-savvy speculators define the next market cycle.

Market Commentary for the week of November 23, 2009

Perception vs. reality.
Despite what appears to be a successful 2009 rebound, we should bear in mind that the recovery bounce has come a long way, indeed, because it has come from such a low origin. Measured over a longer cycle, the basic first upleg in our recovery is nothing more than a significant price spike driven more by value-hunting than by a turnaround in previously corrupt fundamentals. In fact, the net effect to the market (including this year’s recovery) over the last 10 years is zero percent gain.

Secular bulls and bears take decades to unfold. The record is clear that 2009 might have rescued your 401-K, but did little either to establish or refute potentially negative consequences to a growth cycle predicated, at its later stages, upon greed, excess and over-indulgence.

It is upsetting to see a market slide by on complacency. But in reality, very few of my compatriots or clients are convinced enough that this recovery is for real to go “all-in” without discretion.

Those who proclaim these trading rallies as the “real deal” are premature in their conclusion.

History vs. today.
Comparing our present situation to others in the past is also misleading. There have, in fact, been comparable periods in the market’s past, but none identical. We can gain insight from similar market patterns, and we can quantify the probability of market cycle’s performance probabilities even if the patterns themselves are unique. What we cannot know, and current market activity bears this out, is when these cycles and probabilities might unfold.

We know the life span and magnitude of previous bull/bear markets. Referencing the past can be a handy resource but not always a correlative indicator. What we do know is that the depth of the market’s RSI decline before March 2009 gave every signal that the most statistically probable direction for the global market after that date was to go up.

But before we can declare a bull we must go through several important cyclical inflection points and a whole lot of psychological recommitment to owning risk of any kind.

What about tomorrow?
There is no question in my analysis that the next two decades hold the most significant statistical probability of upside performance than at any time since the 1980’s. But I would caution any client, any investor, that the configuration of that opportunity is also the most diverse and unique. The “likely” conclusions are not yet obvious, and may be punctuated by more pain and more mania.

If a turnaround in global markets/economies is to occur we must reconsider the effectiveness of the playing field, and whether or not the rules allow for fairness and opportunity for all participants.

Otherwise, there will be nothing to “give thanks” for, except that this year saved you from more serious declines than you had otherwise expected when the year began.

Market Commentary for the week of November 16, 2009

A top.
Following a compelling weekly rise last week, and the near-completion of a bull rally begun in November 2008/March 2009, my indicators are suggesting that, while the nascent bull trend remains intact, there is increasing evidence that we are bumping-up against cyclic “tops” in near-term performance. Valuations, having expanded significantly during the rally, are offering high/medium risk entry points that raise a level of skepticism about short-term expectations.

Despite the impact of short term stochastic indicators, the longer bull rally, in its infancy, is nevertheless building momentum and gathering a host of earnings momentum and price performance summaries in its wake.

Significant, too, is the breadth of capitalization spectrum of participation globally, from industrial infrastructure to early-stage biotech.

Segmented opportunity.
When spanning the panoply of risk/reward opportunities, my belief in an “earnings acceleration model” generates greater performance probabilities than at any time since the global markets “peaked” in 2006-2007.

Our quest to identify perpetual (secular), thematic opportunity also involves several metrics that broaden any traditional top-down model of industrial development and economic expansion. For instance, a traditional consumer-led recovery is not the paradigm I see at work today. For whatever reason, the key contributor to economic resurgence, at present, is the location of natural resources and domestic intellectual talent. In other words, opportunity is “borderless” except for happenstance in which those precious commodities happen to be located.

In our desire to find these secular themes, our database mirrors a globalization of the playing field, and other objective risk-adjusted performance characteristics.

For example, there now exists a commonality between nations about the need to keep interest rates low. Such congruent monetary policy has, at its core, the desire to make money so affordable that you and I feel compelled to borrow. The trouble with this notion of course, is that absent a robust jobs market, many feel disinclined to take on more debt when they still worry about their jobs. Similarly, corporations feel no obligation to expand hiring, or other capital-intensive projects, if there is no marketplace into which to sell their goods and services.

So, as low interest rates present the potential for borrowing and spending, as well as the nascent seeds of inflation, my oft-writ maxim is as true today as it was in previous recessions: “You can lead a horse to water, but you can’t make him spend.”

Focus longer term.
Recall, too, that we didn’t just fall into these crises, they originated and culminated over time. Huge market sectors don’t simply collapse overnight. Our theses about market data evolve along with the changing landscape. As earnings dissipate, so, too, does a market’s ability to sustain capital gains. Thus, earnings that derive from illogically expansive accounting, or untenable speculation, must reverse and ultimately decline. It’s always that simple, and so complicated at the same time.

When these trend reversals occur, it is necessary to rebalance portfolio asset allocation, either by category, sector, or security type. We did this two years ago and avoided serious downside beta.

Jobs.
In an earlier missive I spoke about the need to address employment as a precursor to fixing the demand-side of the economic equation. Last week we heard anecdotal evidence of a potential shift in hiring practices. Unfortunately, until business perceives a reduction in risk, and an increase in demand, we are likely to have to make do with earnings that are artificially manufactured through “productivity enhancements” and cost-cutting.

The other side of this dilemma would be for someone to create a “better-mousetrap,” a product, an industry, or a social need that is just too compelling for us not to invest.

I see that paradigm in biotech/life sciences, agriculture, environmental controls, healthcare, and alternative energy.

Market Commentary for the week of November 9, 2009

The financial markets pretend to be all things to all the people. For its supporters, it is a playground of opportunity, arbitrage, and capital gains. For its detractors it is a labyrinth of greed, stealth and mistrust. In reality, the playing field is a little of both but, on balance, more the former than the latter.

Why, then, is the generic Wall Street perceived so poorly and generally so misrepresented?

As originally conceived, the “street” is a global exchange of capital. One man’s loss might be another’s gain. One person’s opportunity to make money is correlated to the risks he is willing to bear. The exchange is not an egalitarian zero-sum game. There are losers and winners to the ultimate degree. Anyone can play.

Fairness.
The problem arises when the perception of risk seems to be stacked against anyone but the untrustworthy, the miscreants who manipulate risk-taking into a rigged game only for a chosen few. No matter the regulators or oversight committees, compared to its original intent, the markets have taken on a geo-political context that seems to suck the life, and the opportunity to succeed, from anyone who gets in.

Critics of my thesis might respond by saying that a “new paradigm” of technology and transparency widens the playing field, making opportunity that much more affordable to the masses. Such perversions of fairness don’t exist, or are, at worst, the price of admission.

Of course, either scenario is an exaggeration of the real truth. No such gap between good and evil exists, and besides “my portfolio is up for the year,” they might exclaim.

I would posit that the solo-flying investor is the problem. If he’s in it for his own advantage, he’s not playing the game with the right intent.

Investing is not like a modern day Monopoly game, where he who accumulates the most wins, unless he with the most invests those gains back into the market for a common good. The principle of globalism (and transparency) requires a borderless playing field, not a hoarding of the wealth. Bailout money and Federal stimulus that fails to reach its intended market is money not well spent.

Greed.
I contend, also, that the promise of profits is a misrepresentation of the exchange of capital. There are no guarantees or representations of profit assurances. But the absence of reward takes all the fun out of the exercise and dissuades the unfortunate from even engaging.

Admittedly, it is pointless, and naïve, to expect equanimity in the distribution of capital gains. A little envy and jealousy towards those who “win” is a healthy motivation. But how long can the markets survive squeezing out those who play fairly while rewarding the unscrupulous?

Many thought it would have been wiser to let banks and auto companies fail from their ineptitude. They played the game and lost. Why do they deserve special dispensation? Are the regulators there to regulate…or to reward failure? That’s a good question.

The next leg of any economic renaissance must be couched in a healthy debate not only about profit and loss, but about right and wrong.

Otherwise we are destined to convolute even further the intent of this game we all enjoy playing.

Market Commentary for the week of November 2, 2009

I want to stray from my usually empirical analysis to offer 3 anecdotes, from which you will be asked to draw your own conclusions. These stories might shed some light on how Wall Street and Main Street differ in defining terms. Take for example “profitability,” and “productivity,” sometimes used interchangeably, but most always used to explain why layoffs might enhance the bottom line:

Scenario 1:
A young woman stops in at her local hairdresser for her regularly scheduled monthly appointment at 2pm. The receptionist tells her that she’ll have to wait, they’re running a little late today. An hour later, at 3pm, she finally gets in to see her hairdresser.

“What’s the delay today?” she inquires.

“Oh, management laid off a technician two weeks ago, so our people are “doubling-up” on clients. Sorry if it’s any inconvenience.”

Scenario 2:
A man drives his sedan to the service department of his local auto dealer at 8am Monday morning. He explains to the attendant that he is there for his semi-annual tune-up and repair. Being that he has to take the bus into work, and the bus back later that afternoon, it is imperative that the car be ready by the end of the day. He returns to the dealership at 5:30pm, after having left his place of employment one-half hour early.

“I’m sorry, sir, your car’s not ready yet.”

“What?” he exclaims. “Why not?”

“Well sir, we’re short two mechanics. We had to let them go in August because of poor volume. We got backed up and didn’t start on your repairs until just this afternoon. We’ll try to finish your vehicle as soon as possible.”

Scenario 3:
“Ladies and gentlemen, ABC Airlines is sorry to inform you that the 12:50 flight to Dallas has been delayed up to two hours because of a backup in traffic at another hub.”

Just two weeks earlier ABC Airlines had reported that they were firing 20 pilots and 100 air service personnel due to budget-cutting and cost savings measures.

Do any of these scenarios look/sound familiar to you? And if so, what significance do these everyday anecdotes play in our lives, or of a broader analysis of economic patterns?

Analysis.
No one is foolish enough to suggest that companies must absorb unnecessary expenses, or that they shouldn’t adjust budget items in order to manage profits appropriately. But is should not go unnoticed that these decisions have a ripple effect which resonates far-beyond the intended consequences of managing profits and personnel. Today, we hear so much talk about employment data that I think we need to focus on “preemptive decision-making” versus “strategic growth initiatives.”

Time management is a consequence of “stacking” tasks upon the workplace, and can have a deleterious effect upon productivity, morale, and efficiency.

Economists are concerned about these secondary consequences of productivity “enhancements,” and worry about a “w-shaped recovery” or a second downleg in our nascent economic recovery. Indeed, as it starts to look better, the economy might become overburdened by demand. It’s a nice problem to have, and much further down the road than warrants our concern today. But the ripple effect of yesterday’s decisions do play a part in whether we have the labor force sufficient to meet any actualized pent-up demand.

Additionally, it would be wise to look beyond any gyrations in short-term purchasing patterns and look, instead, at systemic growth industries and patterns that represent capital gains potential for the next five years and beyond. No one’s interests are served by short term gain at the expense of long term strategic success.

While some statistics seem to show year-over-year growth in the economy, consumer spending is weak because incomes remained static, wage rates decline, and unemployment remains stubbornly high. If spending vacillates into the holiday season, savings levels might continue to diminish, while debt could expand. That could lead us to the “second downleg.”

Market Commentary for the week of October 26, 2009

In your head.
What do you think of when you think about investing? Do you dwell upon the vagaries of global economics? Perhaps you conjure a scene from your retirement, beach house and all. Or is “investing” merely a state of mind, panic or serenity?

Typically, this is the first issue I address with any new client, because the subjective processing of objective data is the most unique thing about investing, or any endeavor for that matter.

That is why we have debate, differences of opinion, marriages, divorces, elections, and Wall Street, the original “what’s in it for me” gambit amongst American traders.

I don’t want to spend too much time writing about philosophy this morning. But we do find ourselves at a unique confluence of data from which the direction of the global economy, and the markets, might be determined.

For example, some believe that deflation is working its way into the system, sparked by a decline in consumer demand and an abundance of Federal debt.

But are these price declines driven by poor consumption or a glut of inventory brought on by a decade (or more) of wasteful production excesses? Or might it simply be a case of “incentive pricing,” designed to bring purchasing back into the market and to right the wrongs of overzealous manufacturing?

Well, if it’s your house, for example, and you are the seller, it’s less about any of those data and more about you not getting that dream cottage on the beach.

See what I mean? It’s all in the perception.

So what, then, to make of the financial markets?

In the facts.
For one, the objective data indicates a snap-back in equities, and the potential for further capital gains.

Here is where it gets tricky, though. The key to capitalizing upon these “data,” or trends, is to know what type of an investor you are and, more specifically, what discipline (science) you use to achieve your specific objectives.

The worst signs of the global depression appear to be mitigating, for example. Production is rising, albeit modestly, and month-over-month data suggests that enough momentum is in the global pipeline to make an upturn more permanent.

But the psychological debate continues. The sheer magnitude of rupture transformed everyone’s thinking and made commitment to the markets very difficult. After all, wasn’t it just a decade ago that the “Tech-wreck” nearly wiped out all the speculators?

One’s time frame certainly plays a major role in determining the acceptability of risk. But I contend that statistical jargon and strict data analysis is not what will bring people back, nor make for successful portfolio allocation modeling. Nor will any “urgency” that is artificially imposed upon you by hype, television commercials, or government mandate.

Right now, the markets are performing in spite of a general feeling that it’s not time to get back in. Benign ambivalence is pervasive and now stronger than any earnings report, analyst’s suggestion, or brother-in-law’s stock tips.

How to play it? Dip one toe in at a time; define your methodology; and widen your aperture of “apparent perception” to include valuations, ethics, and merit when making your investment decisions.

Market Commentary for the week of October 19, 2009

Dow 10,000 again, and again.
For those who experienced unbridled joy when the Dow hit 10,000 last week, let me be the first (second, third?) to remind you that we’ve been here before, and before that, too.

Ten years ago we passed the “magical” threshold, that time on the way up and during a fairly strong bull market powered by Tech and dot.com.

More recently we hit 10,000 again, but this time in a downdraft of significant proportion, on our way lower, and to generational historical lows.

Last week the significance of the integer itself was only relevant because it more so represents a redirection from psychological and economic distress experienced during the last three years brought about by capitulation-causes that historians will document for decades to come.

In other words, it’s just another number.

Up or down?
Oh yes, I heard one pundit say that “5 integers is more significant than 4.” But in reality, passing through this benchmark over and over, without any forward progress, is like driving through Cleveland repeatedly on one’s way to the West Coast. If you find yourself constantly crossing the same threshold from different directions then you’re truly driving in circles. Keep in mind that the net 10 year gain in the Dow from the first time we crossed 10,000 to today is zero percent.

Of greater significance is the prevailing, and comparative, trend of the financial averages. While growth and consumption are clearly not at the levels of our first 10,000 sighting, it appears we are making progress towards remediating the ills of global stagnation.

Certain asset classes, such as Basic Materials, Technology, Energy, Utilities and Industrials are remarkably strong and resilient. The credit crunch might have diverted a secular growth market, but it hasn’t derailed it.

A dynamic corporate response is underway, muted slightly by a concerned populace that hasn’t yet mustered the psychological will to consume with discretionary monies. Nonetheless, there is more investment opportunity than at any time in the last three years, and it is time to commit.

Full spectrum.
Yield, which hardly exists in the traditional fixed-income market, is available in global telecommunications, energy, and traditional consumer non-cyclicals.

Capital gains, as alluded to earlier, are germinating in secular, long-term demographics such as industrials and materials (tangible assets).

The difference, today, is in the sequencing of those commitments. Rather than traditional, consumer-led equities signaling the advance, we are finding more modest success in the “back-end” of the market, more defensive themes and brick-and-mortar businesses.

Indeed, reinventing profits and creating top line revenue growth is the challenge for corporations. Squeezing efficiency from job cuts, wage reductions and the like will no longer suffice. Investors are looking for “better mousetrap” companies whose innovation drives new customers and social good-will at the same time.

To keep those ideas replenished, banks need to lend money more freely, and emerge from their cocoon of isolation and handouts/bailouts. When cultivating an environment for strategic growth, one can’t look at oneself as the sole beneficiary, only. Instead, I believe a partnership of corporate, private, public and governmental sponsors holds the ultimate responsibility for making “Dow 10,000” a permanent support level, and not just another back-and-forth footnote.

Market Commentary for the week of October 12, 2009

Let’s get real.
Now that we’ve gotten the fourth quarter starting date out of the way, let’s begin to focus upon more significant data such as earnings, demand, unit volume increases/decreases, and trading patterns.

Just off the top of your head, knowing what you do about your home savings, your job, your neighbors, the neighborhood …would you buy a retail store stock? How about a bank stock?

You might if you’re a “bottom-fisher.” Or maybe a day-trader, or perhaps, even, an altruist who believes they’ll “come around again.”

Would you buy an electric utility, or an energy company?

Or course, your answer depends as much upon methodology as psychology.

Play the trend.
I believe in long-term secular (generational) trends as the ultimate arbiter of portfolio allocation processes. To be fair, I enjoy trading for high powered (or any) short-term capital gains, too. Using cyclic phase methodology only to determine long term patterns limits the scope of my own tools which calibrate location and momentum of financial instruments on any scale, daily, monthly, annually.

But betting against the trend is not my choice. Short term or long, I believe trading patterns and their intricate inflection points, up or down, are a useful tool in mitigating betting by hunch or inference, without any corroborating science.

I feel comfortable, for example, that research in alternative energy sourcing, production and delivery is a secular theme that will yield portfolio profits in this decade. No one needs to scream at me to make me see the potential for return in this sector. Efficient new uses, as well as consumption patterns globally, are more than enough incentive for overweighting these themes.

The theme resonates, as well, into utility stocks and industrial infrastructure. Energy grids, and mass production of new automobiles, occupies a significant content in these metrics. The vastness of possibilities and potentially new alternatives makes you wonder why anyone after the next three decades might buy oil at all?

Technology shares, metals, research and development complement the arc of due diligence.

Infinite choice.
If these sectors resonate from one topic, such as energy, think of the myriad of concentric circles one might envision within their investment portfolio tackling issues like food, water, ecology, national defense, housing?

The fourth quarter (2009) not only opens up a new chronology for our portfolios, but unveils a new era of discussion for portfolio management, methodology, asset allocation, and coffee-table conversation.

Arlington Econometrics Fourth Quarter Commentary

Manic Edge

The market completed its steady climb last quarter, up nearly 50 percent from its twelve-year-lows in early March. Unfortunately, opinion about its ability to sustain upside momentum falls on either end of a psychological paradigm. On a positive note, “everyone” is clamoring to get back in, but on the other side “many” have decided the game just isn’t worth playing anymore. Right now the sentiment data might be more significant than the economy’s underlying fundamentals.

However, fundamentals are improving. Employment data, while not satisfactory, have reversed months of declines. In the early stages of turnaround, modest reversals or declines in acceleration might be viewed as positives.

Risks, too, are more dispersed globally. Domestic commerce is global commerce, as well. It is conceivable, because of information technology, that your local retailer might be as well known in London as he is in your neighborhood. In the next decade, the definition of borders, ownership, and brand identity will evolve in ways that require adaptations to our thinking about what it means to own equities.

In fact, this quarter’s summary indicates a widening of global opportunity, and a shift in secular momentum trends away from the U.S. towards unit volume growth and pricing power from themes whose origins lie in diverse regions. As always, we try to vet opportunity for its intrinsic capital gains value and macro-modeling relevance. The data is now indicating greater capital gains and earnings potential in non-U.S. markets than at any time in the last decade.

Because investors are edgy about a sense of security when investing, I believe it is imperative to adhere to a methodology with which one feels comfortable. If trading is your forte, go with it. If balance and conservatism is to your liking, stay with that. The key, though, is not to deviate from what “feels right” and from what works on an absolute return basis.

I believe market cycles can be identified and quantified as to their location, duration, and magnitude. Indeed, cycles are “parabolic” not “linear.” They always offer entry and exit points, which I refer to as “inflection points.” These are not points at all, really, but periods during which characteristics of accumulation or distribution can be calibrated.

Therefore, investing in trends is not a day-trading profession, but rather a generational opportunity that endures. The direction of interest rates, the price of energy, demographic population shifts, are examples of trends that economists, sociologists, politicians and philosophers use to make learned discourse about the state of affairs. Limiting ones aperture to the “price of semiconductors”, or “when to buy XYZ co.” limits one’s capital gain potential, as well, and might result in negative performance during periods in which the focus is not on those bottom-up characteristics.

While I quickly acknowledge the myriad of diverse and successful investment philosophies, our metrics have worked well for our clients whose focus remains upon wealth preservation, risk aversion, balanced opportunity, and competitive absolute return.

Markets.
The global theme is fluid, not static. We are not suggesting that markets are abandoning the dollar or traditional non-cyclical U.S. companies. Instead, our metrics are showing areas of the globe that are rich with natural resources, labor, intellect, and solutions for macro problems that are devoid of borders or country identity. As this shift in opportunity takes place, we are suggesting one be ready for it and that the trend is already beginning.

Technology has already created a 24 hour marketplace. It also allows for greater transparency and uniformity of data analysis. These shifts have only occurred in the last two decades, during which contemporary data sharing has made global investing less adventurous. As traditional brick and mortar industries have evolved, so too have non-tangible “ether-net” businesses.

Many emerging market countries are learning not only how to produce but how to prosper. The “trickle-down effect” is less a political slogan than it is a reality of capitalism. Although many nations might suffer from a governmental comparison to the United States, they are nonetheless learning to cultivate their natural resources, entrepreneurial spirit, and a willing labor force to sustain economic viability. Whereas these nascent industries might be reliant upon the globe’s more mature market baskets into which to sell, they nevertheless represent a growing commercial challenge to less nimble industries.

Broadening competition from India, China, Germany, Greece, Brazil, Chile and South Africa accelerates the locomotion of secular trends and global problem-solving.

Meanwhile, here at home, growing budget deficits heighten inertia and constraints upon corporate capital expenditures. Our nation’s GDP is choking on a declining labor force, lower discretionary capital, and a psychologically debilitated consumer psychology. With or without Federal stimulus/bailout packages, a growing baby-boom generation is fearful whether their retirement savings will be sufficient or that their quality of life will be as robust as their predecessors.

Our global partners’ unwillingness to finance our largesse might come back to bite us. Friends, and adversaries, are aware of our internal political debate. They see that it might be cheaper to consume goods and services produced elsewhere. In spite of the dollar’s decline, domestic U.S. spending on war, social programs, and infrastructure might be sufficient disincentive for attracting foreign capital. Our trade deficit widens concurrently. Our consumption of exports is outpacing our ability to sell overseas.

Global quality, and competition, is a trend whose roots have already taken hold.

Strategy.
Arlington Econometrics is predicated upon the science that market events are not necessarily random. There are discernable, measurable statistics that can be quantified, secular trends that overlay all data, and cyclical patterns of advance/decline within those longer demographics.

The most significant secular evolution is occurring today in natural resources, particularly food and agricultural sciences. Whoever controls grain production and harvesting, water resources, meat and poultry production, corn, fertilizer and soybeans will be a profit beneficiary of the next secular wave.

While this may be a boon to emerging markets and fertile land resources, we also need to look at how these enterprises are financed in the public and private domain. No government should subsidize the destruction of crop harvests in order to maintain “equilibrium” in the supply chain. Further, no citizen should ever go to bed hungry. Lack of distribution, not production, is the bane of the agriculture industry.

Secondly, energy resources are the most inefficiently applied new science in our database. One of the most significant influences over economic and social policy is renewable energy production. The potential to match declining resources with alternative sourcing is not uniquely an American problem, it is a global problem. Expanding sources of energy production is a governmental responsibly, not just a profit incentive for the private sector. The solutions require technological sophistication and intellectual capital to achieve their ends.

And brain power might be the most important commodity export any nation has to offer. Investments in education, infrastructure, healthcare and security are requirements for emerging markets as well as our most sophisticated industrialized nations. To that extent, countries can provide the capital to each other for a renaissance in commerce as well as mutual protection.

Conclusion.
As the short cycle advance gathers at the top, risk heightens that those on the fence about investing will be dissuaded from jumping in with cash. Every downdraft creates more skeptics. Although the much larger bear correction is nearing its nadir, the recent monthly advance indeed has created a more risky entry inflection point.

I too am cautious about chasing short-cycle advances. However, with the multiplicity of longer-term, secular themes on the horizon I believe acceleration patterns in the market over the next few years will be upwards, not downwards, and will give our clients a chance to benefit from conditions that set the stage for an enduring bull phase.

Rather than living on the manic edge, I believe the science today quantifies fundamentals over fear, profit over hyperbole.





Asset Allocation:
Equity 40%/Fixed Income 25%/Cash 35%

Market Commentary for the Week of September 21, 2009

Art.
Bear in mind that despite the short-term fluctuations in the market, we are still in a bear trend for the most part. Indications are that the magnitude and amplitude of that trend are diminishing, but the predominant direction continues, nonetheless. One might consider, however, that the gathering of equities at the bottom might be a solid precursor to an emerging bull trend, yet unseen, in the same way that a gathering of equity valuations “at the top” was an early harbinger of the bear phase we’re in today which followed an amazing bull expansion of the early half of this decade.

Concurrently, my work is forecasting a redirection of interest rates, from low to high. Indeed the last, best, opportunity for bond purchases was the early 1980’s while the best time to sell one’s fixed-income capital gains is now. Our clients have seen this happening in their portfolios, particularly following the bond market’s resurrection after last year’s collapse. In some cases, we have achieved extraordinary annualized returns on some short-term purchases from those depressed levels.

If, in fact, these projections are correct, they might signal a new wave of inflation in the economy, already sprinkled with anecdotal price increases in energy, foodstuffs, education, healthcare, and personal items.

Science.
While we wait for these, or other, predictions to manifest, it is important to position one’s asset allocation appropriately so as to take advantage of both short and long-term potential. In this regard, I have been paring our fixed income holdings (those “at a profit” with YTM receding), raising cash, and/or building equity positions in thematic long term equities, while trading short-term inflection points. Quite a Herculean task, but so far we have outpaced the rest of the market with considerably less capital exposed to risk.

The range of potential opportunity is spilling across borders and taking-on a global characteristic. Basic Materials, Technology, and Industrials are expanding their profit potential worldwide, responding to demand-driven capital expenditures or consumer purchasing power. Consider that the location of these natural resources might be local (U.S.) or as far away as Brazil, Australia, India, Russia or South Africa. A very long-term view, then, is also a global model for asset allocation.

A decline in downside market momentum is also a good time to purge one’s portfolio of “loser” stocks. For too long, many of these may have represented too large an allocation in your portfolio, too big a loss, or simply too big of a fixation upon one equity within a basket of other securities.

If it is true that asset allocation plays a greater role in the probability of portfolio capital gains than any individual security within that portfolio, then it is time to act like a fund manager yourself, and focus upon portfolio total return rather than upon those one or two thorns in one’s side. This is what the Arlington Econometrics model does best: position our clients so as to mitigate downside risk, while capitalizing upon asset allocation models that enhance total return strategies within each client’s relative tolerance for risk versus reward.

Currently those models show an ever-increasing appetite for the potential in equities versus bonds, but maintaining (in the near-term) a high cash reserve position (25%). It is expected that we will shift cash into equities by the end of the year or the beginning of next.

By sector, I see long-term upside momentum in Energy, Utilities, and Technology, while remaining cautiously underweighted in Financials and Cyclicals.

The market has shown remarkable resilience since the “economic collapse” last year. After a period of rest within this current expansion, I expect a multiplicity of opportunity to emerge from the confusion.

Market Commentary for the week of September 14,2009

Now what?
With global markets seemingly stabilizing, the conversation now shifts to the location of potential long-term capital gains opportunities. Arlington metrics show that all eight significant sectors are bottoming in a long-term accumulation, but that industrials, technology, and utilities are poised to accelerate at a faster rate than their counterparts. This represents a potential improvement in infrastructure and traditional brick-and-mortar businesses.

Obviously, completion of these endeavors takes time, but time may be the risk-mitigating factor. There will be less volatility and more correlation to expected returns as projects near fruition.

Industrials.
For decades, analysts have spoken about the globe’s aging infrastructure. The multiplicity of definitions runs from electric utility grids, to roads, to buildings and to the environment. The characteristics of these projects all lead to social good, as well as profit potential. Additionally, cash flow returns from these projects have the potential to outstrip their original cost. Being attuned to cost/benefit analysis is the new norm in federal and private expenditures.

The bottom-line for clients, though, is capital gains. The resonance of job creation, taxes received, societal benefit, and return-on-investment has my models overweighting these sectors.

Additionally, these projections are borderless. The need, and capital, is everywhere. Cross cultural effort will be required, allowing for accounting transparency and global exposure. It is conservative to forecast that the next upleg in the global bull equity cycle might be its broadest and most significant in generations.

Given the diversity of need, the statistics are in favor of non-developed regions “catching up” to industrialized nations, and for the more advanced economies to “re-boot” their expansion potential. As the percentage of capital flows into these projects increases so, too, does the benefit to the region. Our own Department of Civil Engineering estimated, for example, that over 90% of bridges and roads are at risk, and need reconstruction.

Eyes forward.
As my models gyrate with short-term market activity, it is important to take a step backward, to widen the aperture, and to focus upon sector rotation within the upcoming secular bull-leg. In that context, market activity becomes clearer, and asset allocation modeling becomes more successful.

I do not mean to suggest that short-term trading is inconsistent with portfolio returns. Indeed, clients have noticed a much higher level of short-term activity designed to capture the current level of opportunity in the markets. But long term macro modeling is always the context in which our portfolio success occurs. Asset allocation plays a greater role in the probability of portfolio performance than does any individual security, or trade, within that portfolio. Most of you have heard that before, and it’s true.

Before we succumb to the doomsday scenario, keep in mind that capital always follows need. Simply, find the need.

Market Commentary for the Week of August 31, 2009

I write incessantly about the need to take emotion out of the investment process, about the superiority of science over hunch, fundamentals over guesswork. To a certain extent I am correct, although I acknowledge that no one discipline is absolute, no point of view absolutely foolproof. History, and experience, have shown me, though, that lack of discipline, any discipline in particular, is catastrophic when trying to build portfolio capital gains. In fact, lack of discipline is deleterious to almost any endeavor in life. My background in sports and entertainment has demonstrated that for me.

But I am concerned that the rhetoric and motivation on Wall Street, and Main Street, has shifted far from a logical, fundamental debate to one driven by ideology and greed. Hey, doesn’t greed go with Wall Street? Maybe, but it seems that where profit and money are concerned the conversation goes only one way. And that’s a shame.

One of the most seminal moments in my life occurred in 1968. I remember the inspiring photo of the first “earthrise” taken by the Apollo space mission. In it, we on earth got a glimpse (photographed by man not machine) of the fragility of our own planet as it hung tenuously in space. From that photo came my recognition of the unity of continents, people, countries. Despite our differences we (mankind) all occupied the same vehicle as it hurled through space and time. All that history has ever recorded about us, occurred on what was then dubbed the “big blue marble.”

Why then, in our search for the perfect portfolio, the perfect stock, the next “greatest idea” do we couch those discoveries with the burden of being jingoistic: mine, not yours; ours, not theirs? Is medicine a right or a privilege? Is ownership of technology a profit decision or a matter of making the globe better? While I recognize that these are not either/or issues, nor as simple as I pose them, they are questions to which common response seems to be gravitating toward “mine, not yours.”

“Take back our country” one hears. From what? From sharing the bounty and good fortune that enables many to live well, others not so well?

“Necessity is the mother of invention,” not greed. Rather than “taking,” perhaps profit and innovation derive from “giving,” from finding ways to uplift the globe, sharing its resources and opportunity for all members of the trip. Why not search for profit while aspiring to a higher ideal at the same time?

Renewable energy, abundant agriculture, life-saving medicines, innovative technology, safe homes, secure roads, clean and plentiful seas: these are not only goals but profit machines, no matter which side of the debate you fall on.

Writing letters to your congressmen, or President, decrying the inequity of having to pay for others less fortunate than you, alienates the writer from the other side, those who have less. Is the tax code inefficient? Maybe. Do we need legislative changes to appease the inequities? Perhaps. Does separating oneself from the “other half” solve the dilemma (other than one’s own)? In my opinion, no.

Portfolio management is indeed about science, methodology, point of view, and profit-making. It is also about good sociology and moral conscience. My work seeks to define a top-down topography which is opportunistic in its search for value-added, and long term capital gains. And, we have done an extraordinary job accomplishing those dual purposes.

Be grateful that were you ever to need the healthcare we are all debating now, you have access and opportunity. Be mindful of those less fortunate.

Be grateful for your coffee and cereal in the morning. Be mindful some have not.

Be grateful you have the financial means to afford this “esoteric discussion.” Be aware that some cannot.

Our time on this “blue-marble” is finite. So too are our resources. Do something to make the ride better.

Market Commentary for the Week of August 24, 2009

Inertia.
Worriers, and machines, ruled the markets last week. After flirting with record-breaking new momentum for the past 5 months, the cash spigot was turned off dramatically. Indicators stagnated, then fell, as profit-taking and fear crept back into investing. As if to substantiate the markets’ volatility, consumer confidence and capital expenditures dropped for the week. It’s all so “predatory.”

The most troubling part of this behavior is that the markets become seized by a paralytic horde, first buying then selling everything. Nobody invests with any real conviction, so the whole thing becomes a series of “program trades,” replete with upside sell barriers and downside loss-limits.

It’s no wonder that current reality is on hold for the time being.

But are the markets “out of control,” or merely acting out an orderly progression of accumulation prior to any mark-up phase?

Science, not fiction.
My research indicates that this stop/start progression is more reflective of an end-of-cycle context than random and, somehow, devious plot. After all, doesn’t the end of a secular bull cycle look something similar? Recall that the mania that gripped the final throes of our last (or any, for that matter) bull wave also acted on impulse, greed, and a never-ending belief that equity price increases were inevitable.

Well, here (at or near the bottom of the bear leg) the staccato-like reaction of share prices looks as if no one believes in the upside anymore, and that downside catastrophe is immutably prescribed.

Being foolish is definitionally part of either end of a secular cycle.

In the end, fundamentals always win out. Not just for investing, but for most things, as well.

Which side are you on?
The case for optimism is not rooted in the day-to-day gyrations of equity and bond prices, but in the longer-term demographics which serve both a moral and capitalistic incentive.

My work is laying out the foundation of new paradigms for investing in biopharmaceuticals, alternative (and traditional) energy sources, agriculture, technology and infrastructure, and water purification and distribution.

Your disappointment in equity prices today is shortsighted relative to the magnitude of opportunity, solutions, and potential the globe faces in the next 50 years.

It is important, too, to fight through the week-to-week negativity in order to develop a long-term strategic risk/reward paradigm for investing. Focusing on the excesses and the little things puts you squarely at odds with methodological science, and places you, instead, on the periphery of good judgment.

This missive is not intended as an optimistic misstatement of the facts, but rather a careful observation about the potential for capitalism and morality to coexist profitably. Others may think about throwing in the towel. Our objective data proves otherwise.

Mr. Spock?
As technology becomes obsolete think back to rotary phones, VCR’s, propeller aircraft, analog television. Think also about the future potential in medicine, irrespective of the political context, to solve and cure “incurable” diseases.

Think, also, about the role of the markets in providing long-term capital and speculation for progress in education, life sciences, healthcare, agriculture, and environmental studies.

Worriers will always find justification for their point of view. Let them tiptoe into the future.

Market Commentary for the week of August 17, 2009

It is different this time.
In several of my last pieces I have referred to “a new equilibrium amongst global equity bourses.” By this I mean to say that the declining tide in equity fundamentals worldwide (earnings, manufacturing, productivity, etc.) spared no region, no capitalization, no sector. Simply, the “pause” in global market expansion was all-encompassing.

But I have also referred to this baseline equilibrium as a positive, of sorts, because it affords us as investors a chance to redo our thinking, our analysis, and our asset allocation without the worry about catching a moving target in haste.

The characteristics of this “new equilibrium” include slower earnings growth acceleration, price-driven profits (as opposed to unit volume increases), lower downside risk to equities, sector rotation towards inflation-sensitive stocks, higher nominal interest rates.

My portfolios began to adjust for this new paradigm more than two years ago. When equity markets “broke out” of traditional upside barriers, it became apparent that the low cost of money was skewing traditional growth and investment patterns towards near-manic levels. And, just as psychological depression is no incentive for wading back into stocks, nor is euphoria a reason for buying “anything that moves.” In all cases, either side of the bell curve is not the prime location in which to be.

A return to traditional accounting and fundamental analysis is also a by-product of the hysteria the bull/bear cycle created.

Top-down.
One should remember that market cycles are generational. Although we have the tools to calibrate efficient quotients on a minute-by-minute basis (and the television “talking-heads” who constantly remind us of the necessity to do so), the outlook for capital gains potential lies in broader demographic themes which resonate far beyond commercial earnings cycles.

Longer-term does not mean less excitement. Putting one’s money to work at the proper inflection point means having more than one opportunity to buy. Correlating short-cycle activity within the broader top-down trend is the essence of Arlington Econometrics’ quantitative discipline. We have demonstrated an ability to do more within a cycle than traditional buy and hold investors.

The expansion of our themes began well before the data was perceived by the masses. Thus, the gap in our upside performance versus the S&P, for example, widens over time in our favor.

Ready, set……
I still believe in a higher potential for stocks over the next decade than at any time since the last secular global bull cycle in 1982. Utilizing our value and earnings models, I am forecasting a major three year reversal that can ultimately support the next secular bull phase, and uncover significant sector leadership in the process.

How efficiently we process these data will determine the spread over global bourses we achieve in portfolio capital gains. With so much contraction having taken place, the fun will be in the new competition to perform and to lay out the macro-themes that will guide our allocation decisions.

I believe we are starting to see those themes’ potential in agriculture, biopharmaceuticals, materials, energy, and technology.

For the time being, that should be plenty to digest.

Market Commentary for the Week of August 10, 2009

Is it that good?
For all the right reasons, everyone loves upticks in the financial markets. But bear in mind that all market phenomena are cyclical, not linear, and that nothing goes straight up, or down, without pause or capitulation.

The danger in ascribing too much value to the market’s short-term rise since July, then, is to fail to recognize the overwhelming evidence that we’re still in a secular bear. Albeit slowing in their downside magnitude, the globe’s economic trends are languishing nonetheless. Last week’s mixed bag of unemployment, merger and acquisition, and earnings news highlights an underlying weakness that left the averages searching for momentum.

The “problem,” of course, is that short-term gains are obviously good, and skew the mindset of investors to trade more/invest less, thus elongating the pattern of recovery which might happen otherwise.

In truth, only yield and capital gains can mollify any concerns one might have about portfolio returns and sustainability.

The engines of capital gains, consumer demand and earnings, are at their lowest levels in decades, and strongly suggesting that their demise is not overblown.

For those with a longer-term horizon the future might be brighter, but nothing assured. Vulnerable to political will, and consumer demand, the sectors of greatest opportunity lie dormant until the funding sources kick-in. “It’s not a good idea unless there is demand for it,” would be a handy catchphrase for seeking investment ideas for the next decade. Presently a lot of “good ideas” don’t have the necessary demand.

Process, always.
Investing always implies risk, even within the most conservative of objectives. The goal of any portfolio manager is to balance risk with the total reward, so as to mitigate the impact of wrong choices or market volatility. I expect the market’s risk level to dissipate during the next few months. There is sufficient worry and devaluation built into stock and bond prices so as to level the playing field for most everyone. In the face of poor consumer sentiment and an overriding mistrust of the financial community, investors have a significant chance to recapture lost value through prudent asset allocation. All that’s missing is the correct upcycle and the confidence to “get ones feet wet,” again.

There are some clues that the market will move up in time. Relative strength quotients for financial instruments are rising, making “higher lows.” Hyperbole is being replaced by good old-fashioned fundamental analysis, and demographic themes are emerging which, under the right circumstances, might turn into venture capital and capital gains opportunities.

As more benchmarks “bottom-out,” I am hopeful that magnitude and velocity of bear trends will abate. As said, the response will not be linear, but, rather, cyclical. That should afford us the time to benefit from the upswings, protect against the capitulations, and to balance our asset allocation accordingly.

Market Commentary for the week of August 3, 2009

· Politics and sheer willpower combined to inch the markets higher last week. The absence of something negative was simply enough to get “sideliners” interested in value hunting, and for once (and a little bit) it paid off.

The most combustible elements of the equities markets took a short hiatus, and could best be described as resting at arm’s length from it all.

What’s going on? In short, earnings weren’t as poor as expected, politics took a break from occupying the news cycle, and most global investors hunkered down to assess the successful first month of the new quarter.

As a cessation of negative news might now be interpreted as the underpinnings of a cycle reversal, the only question is whether any negative news might throw cold water on the gains thus far grudgingly won.

For example, the Federal Reserve Chairman commented that he sees “positives” emanating from the bailout activity, as well as a slowdown in the magnitude of cycle decline from the bear market and the economy. His assessment is made (hopefully) from an unbiased point of view, but served to attract investors to the market, capital expenditures from corporations, and some stimulus to the housing market. All this as investors gain a modicum of confidence in the potential for an economic turnaround later in the year.

Certain barometers in my work are offering corresponding conclusions, but with a note of caution. While the short-term relative strength (RSI) numbers are moving higher, they are coalescing around upside resistance points which might be problematic in the near-term. Indeed, before I am willing to anoint the new bull phase, I expect to see some profit-taking from the June-July rally, bringing RSI calculations down to a more manageable level. Recall, that most linear upside rallies (like the kind we are in) are usually met with mirror-like linear capitulations. Buy and hold is definitely not the prudent strategy today.

The effectiveness of one’s portfolio strategy in the near-term will depend upon nimble equity-picking and short-term, high yield fixed income opportunity. At least, that is, until a real bull market takes hold and sector weightings take on a new significance.

I mention this because new clients, as well as existing ones, might be noticing more volatility and “exchanges” in their accounts. Traction, these days, means a short-term head start.

While my methodology always focuses upon long-term, top-down oriented themes, many of those data lay dormant in the short-term. The underpinnings of my long-term analysis remain as I have previously written: the depletion of natural resources, an age of technological discovery and interconnectedness, healthcare and related demographics, as well as social and moral governance of institutions such as financial, educational and infrastructure. Unfortunately, the consumer-led paradigm of traditional “front-end” bull cycles is nowhere on my radar, thus forcing me to underweight Cyclicals, Non-Cyclicals, and Financials.

There is no “truth” to investment strategies, only points-of-view. During tumultuous times it is imperative to modulate one’s investment methodology to reflect the changes in data, not simply to try to place square pegs in round holes.

Last week offered a little something for everyone, but be mindful of the cyclicality in financial markets. Try not to ride the downdrafts as vigorously as you search for the upswing.

· Wall Street is coming at you again, with extreme prejudice. Have you noticed that recent television commercials for financial services (banks, brokerage, insurance) contain one or more of the following: a young child (most likely a daughter); an elderly couple walking arm-in-arm; a beach scene; a skyscraper. These subliminal tugs at your heart are designed to convey trustworthiness, strength, compassion….this from the same firms that almost broke your retirement one year ago. Just asking?

Market Commentary for the week of July 27, 2009

The big picture.
With the globe’s equity markets rising and falling, and investors trying to get out in front of each cyclical swing, it is important to maintain a discipline about asset allocation, and identifying the overriding trends that might offer a less bombastic month-to-month volatility. Despite a tendency to rise or fall in the short term, markets usually are defined by longer term themes which the next generation can more easily label, but which might be obscure to those currently living it. The lifespan of these thematic events is generations, containing several intermediate (5 year) cycles within.

It is no wonder then, that doubt creeps into portfolio managers’ minds when confronted by news events that seem to knock a portfolio off course, but which, if tended to correctly, matters little in the long run.

Let the record show that asset allocation plays a greater role in the probability of a portfolio’s capital gain potential than does any individual security within that portfolio.

Thus, if managed correctly, exogenous news events, or even bad decision-making, might be obviated by implementing prudent distribution of risk, asset classes, and allocation.

It’s right in front of us.
Today, we are at the cusp of one of the most powerful bull recoveries in the last century. Portfolio contraction has been so great that seemingly all asset classes are “starting over” at an equilibrium point that will be sorted out by earnings gains, demographic leadership, and political will.

In fact, nearly all of the last decade’s gains have been destroyed by the bear cycle capitulation during the last 2 years.

Keep in mind that cycles do not simply emerge or begin, they evolve. The market, like the global economy, must recover from significant fundamental flaws to reestablish any sort of reversal. A revival might be likely in the next few months, but it will not be a “V” shape recovery, emanating from a single point in time.

How far, and how strong, the first steps of a recovery might be is a demand-driven equation. Right now, no such pent-up demand exists. Therefore, the most significant component to a valuation expansion and economic renaissance is the psychological one. Today, the “fatigue factor” is too great even to contemplate a reversal’s origin.

But it is exactly now that prudent asset allocators and methodological scientists need to be evaluating the negative data from which to predict the next leading demographic themes. History, as well as intuition, are tremendous assets when embarking upon such an undertaking. And time is certainly on our side.

Although bottoming signals abound, it is not until psychology leads that fundamental data might actualize a price mark-up phase.

Be smart.
By definition, momentum is a coincidental indicator. Therefore a catalyst is needed to initiate the spark. While I am happy to have short cycle upswings within this nascent recovery, I am loathe to call them a secular bull phase until true momentum catches up to fundamental redistributions within the larger economic landscape.

When brief rallies author a euphoria, and pull-backs generate fear, we know that a secular thematic and demographic cycle has not yet exerted its full influence over the broader topography of the financial markets.

If your portfolio is currently on the “losing end,” you should worry that your methodology has little relevance to a prototypically historical bias for upside capital gains in the long run.

Market Commentary for the week of July 20, 2009

Lethargy?
A review of some of the market’s best summer performances yields very little to inspire the notion that we can break out of the doldrums during the next two months. As the U.S. Treasury wrestles with the aftermath of last year’s credit crisis, we are left to confront an “expiring” short-term rally in stocks, as well.

These issues, while not simply academic, inspire a loss of confidence that transcends the sense that maybe we are “turning a corner” on the economy. There are, indeed, many more signals that the global economy is stabilizing, but why don’t consumers feel better?

It could be that objective data doesn’t filter down into the psyche like job security, family health, and peace of mind do. Before the crisis began, legislative officials urged us not to focus on the objective data. Now, we are perhaps being given too strong a dose of reality and in some instances, it’s causing paralysis.

There are no easy solutions. Any legitimate efforts are being met with equally as viable a response from the other side. So unless the momentum shifts in our favor, the markets might choose to hibernate for another summer.

Plenty of time.
My data is actually showing positive signs as the markets “bottom-out.” If you haven’t yet gotten back in, the next few months might provide the right opportunity to diversify your risk profile. Interest rates are rising making short term bonds more attractive. Equities are trading at valuations nearly 60% below their peaks. Despite the reflex rally of the past six months, we are far from establishing a new secular bull phase; we’ve simply begun the bottom fishing and accumulation necessary to cease the rate of downside momentum.

With only a slight risk that you might miss out on a summer rally, I believe that this is an interesting time to prepare for a portfolio rebalancing. Good or bad, low equity valuations provide us with the most potential for capital gains than any time in the last 5 years.

For that opportunity to actualize, however, one must follow certain thematic and methodological covenants. Firstly, follow the earnings trail and the cost side of the accounting ledger. Rising costs, higher inflation, are not necessarily bad for the economy. They may, in fact indicate a surge in activity.

Secondly, one must be sufficiently diversified within/amongst a basket of demographic leaders. Going back over previous bull cycle history, we know that early rallies gain a boost from cyclic indicators that include relative strength outperformers. Those RSI leaders today are Energy, Biotech, Technology, Utilities, and Basic Materials. Laggards are Financials and Consumer Cyclicals despite what the value hunters might tell us as justification for their speculation.

The central idea is simple: we must assume a perpetual secular bias for capital gains. Our interpretation of those data is what makes markets. As the summer languishes, I believe we have an excellent opportunity to adapt to a changing landscape in stocks and bonds, and channel that opportunity into prudent asset allocation strategies.

Market Commentary for the week of July 13, 2009

Typically, our investment approach is oriented not so much around bottom-up stock picking as it is looking at, and evaluating, much longer macro themes and earnings quantification. Today, however, at this juncture where the bear market is seeking equilibrium at the bottom prior to resuming what we hope will be the next bull phase, we find ourselves at an interesting confluence of undervalued equities and long-term demographics. In other words, the playing field is nearly level for all sectors, all regions, all market capitalizations, all themes.

The answer for the search for capital gains begins, therefore, with a hierarchy of societal needs.

Recent declines in sector valuations have caused traders and investors alike to search in unison for investment probabilities that match both short term and long term objectives. By capitalizing upon this unique inflection point, we can build portfolio net worth and redirect the misspent spirit of investing that was destroyed by the latter stages of the last bull phase.

Because of these conditions, my research is pointing at a gathering opportunity in agriculture, food science, and natural resources.

This is not a new play. I have written about these topics for three decades. The usual themes allow us to play market leadership while underweighting the “laggards.” As the globe “shrinks,” due to blended commerce, the internet, and conjoined objectives, the needs of one neighborhood become the business opportunity of another. Traditional borders are being obliterated by common moral imperatives.

These imperatives are creating baskets of investment opportunity in biosciences, gene research, agribusiness and nutrition. In last week’s quarterly I rhetorically asked “Who owns the water?” The tapestry that blends agricultural need with investment entrepreneurship has never been more vibrant.

That is why my work is leading us to countries like Chile, Brazil, Russia, Australia, South Africa, India and China as potential sources for investment ideas.

There is no blame to be laid, simply the idea that the globe’s captive audience has significant social and moral needs to be met.

Now, who has the money and the notion to ante up?

Arlington Econometrics Third Quarter Commentary

Feudal Economy: 2009

Despite the excesses of the past decade in which the gap between rich and poor became wider, it is only during hard times that we gain a sense of perspective about the compassion of others, and our place in a society that either embraces the needs of others or rejects them for their disabilities or lack of initiative. I fear, based upon my reading of anecdotal data, that the laws which might govern our impending economic renaissance are closer to Darwinian survivalism than to universal altruism and good will.

Indeed, all social strata have been harmed by the current financial collapse. As an objective scientist, I am bound by my methods to account consistently for my representation of my data. Therefore, I regrettably report that I have overheard many express the opinion that it’s your fault you’re in a financial pickle, and it’s your responsibility to do something about it, and to make sure it doesn’t happen again. “Government is neither the problem nor the solution,” they say. “I’m not taking responsibility for the other guy, either” is another phrase I hear quite often.

Given this level of suspicion and greed which permeates the financial landscape, we might as well erect castles and moats to protect the haves from the have-nots, the privileged from the cerfs.

Whenever we get into a comparison of levels of distress we fall victim to a narrative that cannot be justified. Rather than casting doubt upon other’s motivation, it might be less costly to fix the system which promulgates the inequity in the first place. Let me ask, for example, “Who owns the food, or water, or energy resources of the globe?” Is it sheer happenstance that borders have been delineated, and countries identified, as the regions of bounty? The total bill spent to protect one’s resources is sometimes greater than the revenue drawn in by its export value.

Should stockpiling in one’s basement be encouraged? Remember bomb-shelters during the 1950’s? The fact that a government won’t, or can’t provide, for its neediest is simply not intuitive to good governance. That you are satisfied is not sufficient to cover-up the primal inefficiencies of the system. A better approach might be to encourage equal access to global resources, and to let the capitalists profit from a broader exchange of products and services.

Markets.
As we implement the allocation strategies of our portfolios is it not fair to ask if education, healthcare, housing, energy are rights of a citizenry, or are they commodities available for purchase (and stockpiling) by the highest bidder? Accordingly, when these commodities (services) reach the fewest number of participants are we to value them more, or less in the marketplace? Is the global marketplace governed by feudalism or altruism?

One might pause to consider whether we are dealing with one economy, or two.

There will always be opportunity for the entrepreneur to flourish. From amongst the ruins of our recent bear market decline strategists and opportunists will find/are finding tolerable risk and opportunity. One’s point of view determines those risks, and the willingness of undertaking the challenge. Further, risk-taking provides the opportunity to “be first” with the reward and to surge powerfully past one’s competition. Don’t forget, too, that the rush of emotion from investing is a powerful aphrodisiac. There are no perfect investments. We can only try to mitigate the effect of negative influences upon our investments as best we can. Investing is risk-taking. The probabilities we use to balance those risks are unique to each investor.

When excesses in real estate lending, financial services and commodities draw down all investment vehicles indiscriminately, the sympathetic aftershocks affect more than the intended few. This is when moral compassion and resilience are needed most. A collapse of one sector has the potential to aggravate parts of the economy previously disaffected, or disinterested, in the aggressor. While the panic phase of last year’s bear has largely stopped, a devastating wake has been created. Commercial institutions have the financial resources to rebound more quickly than the average citizen. Financial bailouts, one might argue, are inherently unfair. It can only be hoped that the beneficiaries of governmental largesse are compassionate enough to use their financial “windfalls” to benefit their clients, and not simply to use the cash to adjust their balance sheets.

Strategy.
Since the 1990’s the corporate sector has benefited from fiscal and monetary policy that enabled profitability and growth. So, too, has the investing public at large. Today, however, we stand in sharp contrast to that congruence of shared risk/reward. The “other” economy has been decoupled and left adrift as corporate priorities have been addressed first.

While the business cycle plays out, some are left to fend for themselves. As I stated earlier, these times present unique problems. Many are unwilling to fulfill their neighborly duty to lend a hand because they believe it is not their responsibility to do so. The impact of corporate greed and malfeasance was not their doing, directly, they believe. So even though the pain reverberated universally, other’s chaos is none of their neighbor’s business.




I suspect that this attitude permeates across all social strata, not given to the wealthy alone. But to some extent a level of isolation in bad times cannot be a good thing for the overall welfare of the economy. An asymmetrical discourse about public/private policy is emerging, whose end result could be more devastating than the events which got us here. I believe that without a moral compass, corporate and governmental response could exacerbate the failure already in motion.

Governments are trying aggressively to respond to the crisis. Financial institutions are much steadier than they were, economic activity is increasing, interest rates are stabilizing. Many of the variables, in regulation and psychology, are being addressed by the globe’s leaders. Conventional policy matters are quickly being brought under control. But is this a conventional time?

Conclusion.
If my research is correct, the market’s response to policy changes has been tepid, at best. Indeed, our Technology brethren were correct about New Paradigms; they were just a decade too early in their market enthusiasm. Any expected rebound in retail business/economic activity will be price induced, not simply demand-driven, and inflationary for the foreseeable future. The cost of money cannot go down any further. That strategy has already been tried, and led to a climate of excess and manipulation.

Stresses associated with “keeping up with one’s neighbors” will be supplanted by new concerns about healthcare and job stability. Spending will be sluggish. Personal savings rates, at least in the early part of a recovery, will be anemic.

The spectre of inflation will be most felt in global agriculture. The mania that drove real estate (and dot.com) will be nothing compared to the price speculation in natural resources such as food, agricultural land development, commodities, and water. In fact, I recall writing an editorial last year in which I stated that water could become the “new oil.” Core cost inflation is only going to increase.

Our asset allocation models are becoming more bullish, though. Inflation is not an inhibitor of growth, it is a sign of it. I expect emerging markets to regenerate. Energy, in all of its iterations (and those which we cannot yet imagine), will be a capital gains opportunity for the next two decades, at least.

While all investing is perception, I believe this bear market is a natural parabolic phase within an overall secular bull market. The effects of this bear are more unique because its impact upon all economic strata was pervasive, not limited by sector or region. The crisis was/is just worrisome enough that many global economies have taken historic steps to bring about a reversal. In this regard, some regions are more well-off than others. To a certain degree, however, all regions are poised again at an equilibrium starting point.

Who leads, and who follows, is the nature of forecasting. In whichever case, it will be necessary to address historic psychological and fiscal inequities that destroyed the playing field for a few. Our willingness to provide for the less fortunate will determine the sustainability of whichever stimulus policies set the stage for our predictions.

At some point bear markets become buying opportunities. Recent market negatives are powerful indicators that an upside response is likely. In the near-term, I expect the markets to capitulate (downwards) from their recent rally. But volatility data is indicating a pattern of “higher lows.” Although resistance levels are significant, the market’s pattern is building towards a “breakout,” likely by the end of the year if no further machinations impede an orderly flow of cyclic balances.





Asset Allocation:
Equity 35%/Fixed Income 35%/Cash 30%

Market Commentary for the week of June 22, 2009

Next week/next year.
A majority of global markets are witnessing a slowdown in cyclical upside momentum, as this “second-leg” of the intermediate recovery rally starts to lose steam. Although a major new bear phase is unlikely from here, the deceleration of relative strength indices is still problematic, nonetheless. Did you think you could sustain an overbought rally without any capitulation or consequence? (Editors note: If you answered “yes”, then you still haven’t learned anything, have you?)

I believe that longer term risks are abating. Elected officials are getting a grip on economic fundamentals and trying to right the ship. Although most of the damage had been severe, the markets are now more concerned about where we go from here than whom to blame. For this reason, I see the market’s valuation declines as an opportunity, not a liability.

It is interesting to try and identify the sectors of least distress. I am focusing upon demographic and secular opportunity in Energy, Technology, Agriculture (Consumer Non-Cyclicals), Biopharmaceuticals, and Utilities. These sectors are showing strong indication of resilience, recovery and capital gains potential, as well as inventiveness and ingenuity for lesser-known names within those groupings.

Interest rates.
I am concerned, however, about the durability of bond portfolios in a rising interest rate market. So far this year I have pared down our allocation in fixed income by capitalizing upon a price recovery in bonds from last year’s low-water mark, and by locking in any capital gains which I now fear are vulnerable if rates rise in the next 2-3 years. I still remain committed to a “balanced” allocation in our portfolios in order to diversify risk and income potential, but I am mindful, too, that bonds are not immune to price swings which might adversely affect portfolio performance. In fact, given the severity of the equity market’s collapse, I see greater potential for portfolio protection and capital gains within a prudently diversified equity portfolio than through a predominately “risk averse” strategy of owning bonds, exclusively.

I don’t think the selloff, or depreciation potential, in bonds is overdone, or yet finished.

That doesn’t mean that I don’t see value in owning bonds. But any additions I might make at this time would be of relatively short duration. We are in no danger of missing out on the “buy of a lifetime” in bonds. Those opportunities passed us by 5 years ago.

The economy: who’s “right?”
A popular concern is about a protracted stagflation brought upon by ever-increasing deficits and by an ever-diminishing supply of natural resources. These worries run the spectrum from “growth declining” to “major calamity.” Actually, I currently subscribe to neither of those scenarios. While fully aware of an increase in liquidity in the marketplace, I am hopeful, at present, that this liquidity represents the seed money to quell market declines in the future, and to provide investment capital that yields a “return on investment.”

Notably, doomsday concerns are typical from those who believe we have peaked our productivity potential. But these times might be different because the pace of stimulus required to regenerate the global economy will be quickened by an innate demand for solutions to our systemic problems. Any worries about an escalation in negative effects are premature, in my opinion. We are already in a financial mess. The immediate months ahead require remediation, not fear.

Overall, concerns about economic stagnation should be discounted by the depths from which the crisis placed us. It is unlikely for prices, productivity, valuations or ethics to sink much lower than they already have.

I remain positive about the secular potential in global equity markets. While the near-term might be punctuated by a necessary capitulation, (June-November, perhaps), I am a net-buyer of shares that most typify my cycle phase methodology, and which are at sufficient inflection points to merit a long-term commitment.